10 Equity Comp Terms You Should Know if You Work in Tech
Equity compensation is a cornerstone of the tech industry, acting as both an incentive and reward for talented professionals. But for newcomers and seasoned pros alike, the terminology can be baffling. Here are 10 equity compensation terms you should know if you work in tech and want to better understand your stock-based compensation package.
1. Equity
At its core, equity represents ownership in a company. When a company offers you equity, it’s giving you a stake in the business—usually in the form of stock or stock options. This ownership can give you a claim on the company’s future profits and growth. For employees, equity is often a way to share in the upside of the company’s success, but it usually comes with vesting schedules, restrictions on selling, and potential tax consequences.
2. RSUs (Restricted Stock Units):
A promise from the company to give you shares (or the cash equivalent) at future vesting dates. Unlike stock options, you don't have to buy RSUs; they're given to you.
3. Stock Options
These contracts grant the right, but not the obligation, to buy shares at a set price. They come in two main flavors:
ISOs (Incentive Stock Options): Tax-advantaged stock options for employees. However, when they are exercised en masse, they can trigger AMT taxation - something to watch out for.
NSOs (Non-Qualified Stock Options): Stock options without specific tax advantages, which can be granted to employees, consultants, or board members.
4. Vesting
This refers to the process by which an employee gains access to their stock or stock options over time. A common schedule might be a 4-year vesting with a 1-year cliff. In this example, you'd get 25% of your options or shares after one year (none if you leave at month 11), and the rest distributed over the remaining three years, typically in monthly or quarterly increments.
5. Exercise
This is the act of paying money to convert stock options into actual shares. Newcomers often don’t realize that exercising requires cash up front (plus possibly taxes).
6. Strike Price (or Exercise Price)
This is the locked-in price you can buy shares for, not the current market value. Many confuse it with the stock’s trading price.
7. Fair Market Value (FMV)
Not the same as the strike price. FMV is the current value of a share—either the trading price if the company is public, or an appraised value (like a 409A) if private. When you exercise options, the gap between the FMV and your strike price determines whether you owe taxes.
8. Liquidity Event
Owning private company stock doesn’t mean you can cash out anytime. A liquidity event is when shareholders finally get the chance to turn shares into cash—most often through an IPO (when the company goes public) or an acquisition (when another company buys it).
9. Dilution
As companies issue more stock (for new employees, investments, etc.), your percentage ownership in the company might decrease. This is called dilution. However, the hope is that the company's overall value increases, making your smaller piece worth more.
10. 83(b) Election
A tax strategy move where you opt to pay taxes on the total fair market value of your equity upfront, rather than as it vests. This can be beneficial if you believe the company's value will rise significantly.
Navigating the landscape of equity compensation can be challenging, but understanding these terms is the first step to unlocking its benefits. As always, when dealing with equity and potential tax implications, it's wise to consult with a financial advisor or tax professional to make informed decisions.
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